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Glenn Hegar  ·  Texas Comptroller of Public Accounts

Reporting Requirements for Annual Financial Reports of State Agencies and Universities

General Accounting

Specialized Accounting
Troubled Debt Restructuring

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Scope and Criteria [+]

GASB 62 provides standards for accounting and financial reporting for the debtor and creditor in a troubled debt restructuring. GASB 62 does NOT provide guidance for:

  • Accounting for allowances for uncollectibles
  • Methods for estimating amounts of uncollectibles
  • Governments who have filed for protection under chapter 9 of the U.S. Bankruptcy Code

If the creditor, for economic or legal reasons, grants a concession to the debtor that it would not otherwise consider, then the restructuring of debt is considered to be a troubled debt restructuring. Reasons for the concession could be the result of either:

  • An agreement between the creditor or debtor
    –OR–
  • Imposed by a court ruling

In a troubled debt restructuring, a combination of one or more of the following situations may occur:

  • The debtor transfers receivables from third parties, real estate, or other assets to the creditor to satisfy a debt fully or partially. The transfer may result from foreclosure or repossession.
  • The debtor grants an equity interest to the creditor to satisfy a debt fully or partially; unless the equity interest is granted pursuant to existing terms for converting the debt into an equity interest.
  • The debtor and the creditor agree to modify the terms of a debt in one or more combinations of the following:
    • Reduce the interest rate for the remaining life of the debt. The reduction may be absolute or contingent.
    • Extend the maturity date(s) at an interest rate lower than the current market rate for new debt with similar risk.
    • Reduce the face or maturity amount of the debt.
    • Reduce accrued interest. The reduction may be absolute or contingent.

Examples of troubled debt restructuring combination:

  • Creditor restructures the terms of a debt to reduce or defer the debtor’s cash payments in the near future to help the debtor improve its financial position and be able to pay the creditor eventually
  • Creditor accepts cash or other assets to satisfy the debt although the value received is less than the debt amount because the creditor decides that this action will maximize recovery of its investment

Whatever the form of concession granted by the creditor to the debtor in a troubled debt restructuring, the creditor’s objective is to make the best of a difficult situation.

Restructuring of each receivable or payable, including those negotiated and restructured jointly, is accounted for individually.

Troubled debt restructurings may occur before, at or after the stated maturity of debt. Time may elapse during the different steps of the process.

A debt restructuring is not necessarily a troubled debt restructuring even if the debtor is experiencing some financial difficulties. A troubled debt restructuring does not exist if:

  • The fair value of assets or an equity interest that the debtor transfers to the creditor in full satisfaction of the debt at least equals:
    • The creditor’s recorded investment in the receivables
      –OR–
    • The debtor’s carrying amount of the payables
  • The creditor reduces the interest rate on the debt primarily to reflect a decrease in market interest rates so as to maintain a relationship with a debtor that can readily obtain resources from other creditors at the current market interest rate.
  • The debtor issues new marketable debt in exchange for its debt. The effective interest rate on the new debt is based on its market price that is at or near the current market interest rates of debt with similar maturity dates and stated interest rates issued by non-troubled debtors.

Standards for troubled debt restructurings do not apply to changes in lease agreements or employment-related agreements (for example, pension or other postemployment benefit plans and deferred compensation contracts).

The state of Texas has historically been the creditor in troubled debt restructuring. However, the following information outlines the accounting and disclosure requirements for both creditors and debtors.

Accounting by Creditors [+]

Creditors account for a troubled debt restructuring according to the type of the restructuring as described in the following sections.

Full Satisfaction of Debt

A creditor may receive either physical or intangible assets in full satisfaction of a troubled debt restructuring and may also receive in full satisfaction of debt if the debtor, in full satisfaction of a receivable, gives the creditor:

  • Receivables from third parties
  • Real estate or other assets
  • Shares of stock and/or an equity interest in the debtor

A creditor accounts for those assets (including equity interest) at fair value at the time of the restructuring:

  • If an active market exits, the assets are measured and transferred at the current market value.
  • If no active market exists, use the selling prices of similar assets for which there is an active market.
  • If no market price is available, estimate the fair value by making a forecast of expected cash flows.

Loss recognition is recorded as the recorded investment in the receivable minus the fair value of assets received. Use the recorded investment in the receivable instead of using the carrying amount of the receivable because the latter is net of allowance for estimated uncollectible amounts or other valuation account.

Modification of Terms

A creditor in a troubled debt restructuring involving only the modification of terms of a receivable accounts for the effects of the restructuring prospectively as:

  • The recorded investment in the receivable at the time of the restructuring does not change unless that amount exceeds the total future cash receipts specified by the new terms
  • The effects of changes in the amounts or timing (or both) of future cash receipts designated as interest or face amount is reflected in future periods
  • Constant effective interest rate (interest method) is applied to the recorded investment in the receivable at the beginning of each period between restructuring and maturity to compute interest revenue
  • The new effective interest rate is the discount rate that equates the present value of the future cash receipts specified by the new terms (excluding contingent receivable) with the recorded investment in the receivable

If the total future cash receipts under the new terms of the receivable (face amount and the interest) are less than the recorded investment in the receivable before restructuring, the creditor:

  • Reduces the recorded investment in the receivable to an amount equal to the total future cash receipts specified by the new terms
  • Recognizes the amount of the reduction as a loss
  • Does not recognize any interest revenue on the receivable for any period between the restructuring and maturity of the receivable

Combination of Types

A troubled debt restructuring may involve receipt of assets (including an equity interest in the debtor) in partial satisfaction of a receivable and a modification of terms of the remaining receivable.

  • A creditor:
    • Accounts for the assets received at its fair value
    • Reduces the recorded investment in the receivable by the fair value of the assets received
  • Loss recognition applies if the remaining recorded investment in the receivable exceeds the total future cash receipts under the new terms of the receivable
  • Future interest revenue, if any, is determined using the rules described above under Modification of Terms

Methods for Recognizing a Loss

There are several methods for recognizing a loss:

  • Recognize losses (to the extent they are not offset against allowances for uncollectible amounts or other valuation accounts) in the period of restructuring.
  • A loss from reducing the recorded investment in a receivable may have been recognized before the restructuring by recognizing an expense for an estimate of uncollectible amounts and increasing an appropriate valuation allowance. If this is the case, a reduction in the recorded investment in the receivable is a deduction from the valuation allowance — rather than a loss for the period of restructuring.
  • A valuation allowance can also be used to recognize a loss that has not been previously recognized. For example, a creditor with an allowance for uncollectible amounts pertaining to a group of receivables including the restructured receivable may recognize a loss in the period of restructuring by estimating the appropriate allowance for remaining receivables — including the restructured receivable.

Contingent Receipts

There could be contingent receipts as the result of a troubled debt restructuring, such as:

  • Amounts designated as interest or face amount receivable from the debtor may be contingent on a specified event or circumstance. For example, specified amounts may be receivable from the debtor if the debtor’s financial condition improves to a specified degree within a specified period.
  • To determine if the creditor will recognize a loss, include the contingent amounts in the total future cash receipts under the new terms only if those amounts meet the criteria for accruing a loss contingency.
  • If a troubled debt restructuring involves contingent receipts, do not recognize interest revenue on those contingent amounts before both the contingency has been removed and the interest has been earned.
  • Before recognizing interest revenue, deduct the contingent receipts from the recorded investment in the restructured receivable to the extent that recognition of a loss can be avoided.

Estimated Future Cash Receipts

As a result of interest rate fluctuations, future cash payments may be accounted for using estimates of minimum total future receipts based on the interest rate in effect at the time of the restructuring. For example, the restructured terms may specify the stated interest rate to be the prime interest rate increased by a specified amount or proportion.

Fluctuations in the effective interest rate after the restructuring due to changes in the prime rate or other causes are accounted for as changes in estimates in the period the changes occur.

If the interest rate decreases to an extent that the minimum total future cash receipts determined using that interest rate falls below the recorded investment in the receivable at that time — in which case, the creditor recognizes a loss and reduces the recorded investment in a restructured receivable.

Direct Costs

Legal fees and other direct costs incurred by a creditor to effect a troubled debt restructuring are included in expense when incurred.

Receivable From Sale of Assets

When a debtor sales assets that were previously obtained in a troubled debt restructuring, the resulting receivable to the creditor is accounted for according to the rules described in the “Interest Costs — Imputation” section of GASB 62, regardless of whether the assets were obtained in satisfaction (full or partial) of the debt.

Recognize gain or loss on sale of assets for the difference between the amount of the new receivable and the carrying amount of the assets sold.

Accounting by Debtors [+]

Debtors account for a troubled debt restructuring according to the type of the restructuring as described in the following sections.

Full Settlement of Debt

A debtor may transfer the following assets to the creditor in full settlement of a payable:

  • Receivables from third parties
  • Real estate
    –OR–
  • Other assets

A debtor accounts for the assets (including equity interest) at fair value at the time of the restructuring if:

  • An active market exists, at the current market value.
  • No market exists, at selling prices of similar assets in active markets.
  • No market price is available, at estimated fair value based on a forecast of expected cash flows.

A debtor recognizes either a gain or loss on the restructuring of debt in the period of the transfer if:

  • The carrying amount of the payable is more than the fair value of the assets transferred, a debtor will recognize a gain on restructuring of debt.
  • The carrying amount of the payable is less than the fair value of the assets transferred, a debtor will recognize a loss on restructuring of debt.

Modification of Terms

A debtor in a troubled debt restructuring involving only the modification of terms of payables accounts for the effects of the restructuring prospectively as:

  • The carrying amount of the payable at the time of the restructuring does not change unless that amount exceeds the total future cash receipts specified by the new terms
  • The effects of changes in the amounts or timing (or both) of future cash receipts designated as interest or face amount is reflected in future periods
  • Constant effective interest rate (interest method) is applied to the carrying amount of the payable at the beginning of each period between restructuring and maturity to compute interest revenue
  • The new effective interest rate is the discount rate that equates the present value of the future cash payments specified by the new terms (excluding contingent payable) with the carrying amount of the payable

If the total future cash receipts under the new terms of the payable (face amount and the interest) are less than the carrying amount of the payable before restructuring, the debtor:

  • Reduces the carrying amount of the payable to an amount equal to the total future cash payments specified by the new terms
  • Recognizes a gain on restructuring of payable equal to the amount of the reduction
  • Does not recognize any interest revenue on the payable for any period between the restructuring and maturity of the payable

Combination of Types

A troubled debt restructuring may involve partial settlement of a payable by the debtor’s transferring assets to the creditor and a modification of terms of the remaining payable.

  • A debtor:
    • Accounts for the assets transferred at its fair value
    • Reduces the carrying amount of the payable by the fair value of the assets received
  • Gain recognition applies if the carrying amount of the payables exceeds the total future cash payments specified by the terms of the debt remaining unsettled after the restructuring
  • Future interest expense (if any) is determined using the rules described above under Modification of Terms.

Recognizing a Gain

Do not recognize gains involving indeterminate future cash payments as long as the maximum total future cash payment may exceed the carrying amounts.

Contingent Payments

There could be contingent payments as the result of a troubled debt restructuring, such as amounts designated as interest or face amount by the new terms may be payable contingent on a specified event or circumstance. For example, the debtor may be required to pay specified amounts if their financial condition improves to a specified degree within a specified period.

Recognize contingent payable amounts as payables and interest expense in future periods. Interest expense should be recognized in each period which:

  • It is probable a liability has incurred
    –AND–
  • Amount can be reasonably estimated

Before recognizing payable and interest expense for amounts contingently payable, deduct accrual or payment of those amounts from the carrying amount of the restructured payable to the extent that contingent payments prevents recognition of a gain at the time of restructuring (GASB 62, paragraph 144).

Estimated Future Cash Payments

As a result of interest rate fluctuations, future cash payments may be accounted for using estimates of minimum total future payments based on the interest rate in effect at the time of the restructuring. For example, the restructured terms may specify the stated interest rate to be the prime interest rate increased by a specified amount or proportion.

Fluctuations in the effective interest rate after the restructuring due to changes in the prime rate or other causes are accounted for as changes in estimates in the period the changes occur.

The carrying amount of the restructured payable should remain unchanged and future cash payments reduce the carrying amount until a gain is recognized.

Direct Costs

All direct costs incurred by a debtor to effect a troubled debt restructuring are deducted in measuring gains or included in expense if there is no gain.

Glenn Hegar
Texas Comptroller of Public Accounts
Questions? Contact statewide.accounting@cpa.texas.gov
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